All our branches are now open. Health and safety remains our main priority, and in line with government’s advice, a number of strict measures have been put in place to protect our staff and customers

The EIS and VCTs – Powerful Tax Planning Tools!

The EIS and VCTs – Powerful Tax Planning Tools!
The Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT) both offer significant tax incentives to investors, and used creatively, they provide some remarkable tax planning opportunities.


The two schemes both offer immediate income tax relief (at a rate of 30%) on the amount invested, and in both cases any capital gain when the investment is realised is tax free. The tax reliefs can be summarised as follows:

 

Tax Relief

EIS

VCT

Income tax relief at 30%

On up to £500,000*

On up to £200,000*

Must hold investment for

3 years

5 years

CGT exemption on disposal

Yes

Yes

CGT deferral (see below)

Yes

No

Business property relief for IHT

Yes (after held for 2 years)

No

Tax free income from investment

No

Yes

 

* The limit is to increase to £1million for both schemes after 5 April 2012, subject to EU approval. Note that the relief is limited to the amount of income tax you have actually paid in the tax year of your investment (or, in the case of the EIS, in that year and the previous one).


In the case of the EIS, you can defer any amount of capital gains (more than the £500,000 which is the limit of the income tax relief, if you wish) by investing the amount of the gain in an EIS company. The gain becomes chargeable when you cash in the investment, but can be deferred again if you reinvest in another EIS company.


Is This Available for Everyone?


The types of business which can qualify for EIS or VCT status are tightly defined, but this need not be your concern (unless you are being asked to invest in a friend’s business, in which case it may be possible to structure things in such a way that you qualify as an EIS investor). There are several providers in the marketplace who design specialised investment vehicles which qualify for these tax reliefs.


These investments have traditionally been regarded as “risky”, but there are now some products available which minimise the risks associated with investing in trading companies (which is essentially what both schemes involve).


Let us look briefly at a couple of the ways these schemes can be used in tax planning:


Cash Extraction from a Company


If your company has lots of cash which it does not need, the most tax efficient way to extract it is generally to pay a dividend, but if you are a higher rate taxpayer, you will have to pay income tax at an effective rate of 25% on the dividend, or 36.1% if you are a 50% income taxpayer.


Say you are a 40% taxpayer and you pay yourself a dividend of £100,000, and invest £83,333 of it in the EIS. You will have covered the tax on the dividend, and have £16,666 in your pocket. Assuming all goes well with the EIS company, in three years’ time you will get your £83,333 back, free of tax. There are some company owners who do this on an annual basis, and of course once they have been doing it for three years, they are getting £100,000 tax free each year (assuming they extract and invest £100,000 each year).


Pension Planning


The annual limit of £50,000 on contributions to a pension scheme means that some people are looking at VCTs as an alternative. Although the tax relief is only 30% compared to the relief at your marginal rate of 40% or 50%, in practice, for most taxpayers, the rate of relief will be the same, unless they have a very large amount of income at the higher rates of tax. Looked at in the longer term, the rate of relief is actually higher in a VCT, because if you reinvest in another VCT after you get your money back in five years’ time, you get another 30% tax relief on the amount reinvested. And another point – income from the VCT is itself tax free, whereas a pension is taxable!


Practical Tip


These are only a couple of examples of how the tax reliefs on the EIS and VCTs can be made to work for you. A good tax adviser will be able to come up with many others, and a good Independent Financial Adviser will be able to recommend which of the numerous schemes best suits your needs and your attitude to risk.


By James Bailey